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Ford Motor Company Earnings: Profits Down on New Product Costs

Pre-tax earnings fell over 50% as the company gears up to launch its all-new F-150 pickup.

A complicated factory changeover to build the all-new 2015 F-150 meant that Ford had fewer 2014 trucks to sell during the third quarter. As expected, its profits took a hit. Source: Ford Motor Company.

Ford Motor Company (NYSE:F) on Friday reported third-quarter net income of $835 million, down $437 million from a year ago, as a heavy schedule of new-product launches hurt sales and drove costs higher.

Excluding about $160 million in one-time items, Ford made $0.24 a share, well ahead of the $0.19 consensus estimate of Wall Street analysts.

The best way to understand Ford's quarterly earnings reports is to look at the results from each of its major business units. Keep in mind that the numbers at the business-unit level don't include the effects of taxes.

North America Former Ford CEO Alan Mulally was fond of saying that North America was the "engine" of Ford's global business. That's still true, but the engine sputtered a bit in the third quarter: Ford North America reported a profit of $1.41 billion, down $886 million from strong results a year ago, with an operating margin of just 7.1%.

Why the decline? Two big factors were responsible, neither of which was unexpected. First, Ford's sales and revenue were down 8% and 6%, respectively. Much of that decline was simply due to factory downtime related to Ford's heavy schedule of new-product launches, including the launch of an all-new F-150. Ford's Dearborn Truck Plant was down for five weeks during the quarter as the company began an extensive retooling effort for the truck; that downtime cost the automaker tens of thousands of units of production.

The second factor in the decline was a $632 million year-over-year increase in what Ford calls "warranty costs." No, Ford's cars and trucks have not suddenly become much less reliable and needed more repairs. Rather, the company has sharply increased the amount it holds in reserve against the possibility of future recalls -- a conservative move in response to heightened regulatory scrutiny that has followed GM's recall scandals this year.

Ford warned late last month that its warranty reserve costs for the full year would be about $1 billion higher than it had expected. The company took about $400 million of charges in the first quarter; Ford CFO Bob Shanks told me in an interview that he does not expect significant charges in the fourth quarter, but that could change if the company has to conduct another significant recall.

Ford reiterated its recent guidance: It expects full-year profit in North America to be lower than last year's, with full-year operating margin "at the low end" of the 8%-9% range. Through the first three quarters, Ford North America's operating margin was 8.7%.

Ford gave us one more crucial piece of guidance related to North America on Friday: The launch of the new F-150 is "on track." That bodes well for big improvements in 2015.

South America Ford has had a substantial presence in South America for decades, but in recent quarters the unit has been challenged by a weakening economy in Brazil and restrictions in Argentina and Venezuela. The unit lost $170 million in the third quarter, down from a $160 million profit in the third quarter of 2013.

Ford's wholesale volume and revenue were down by 21% and 17%, respectively, mostly due to issues in the countries mentioned above. The automaker is expanding and overhauling its product line in South America; it noted that better pricing offset some of the lost revenue from the sales decline.

The all-new 2015 Ford Ka is expected to help boost Ford's South American results in the fourth quarter. Source: Ford Motor Company.

Ford warned in September (and reiterated on Friday) that its full-year 2014 loss in South America would be about $1 billion; through the first three quarters, it has lost $975 million. Shanks said the newly launched Ford Ka mini car was selling briskly and should help fourth-quarter results, but the company (and everyone else who does business in the region) is closely watching Venezuela, where the situation appears to be worsening.

Europe Ford Europe has posted big losses for the last few years, as steep recessions in several key markets drove new-vehicle sales to lows not seen in many years. Ford has been working on an aggressive restructuring plan in Europe, and it appears to be making progress. But that didn't help third-quarter results: Ford Europe lost $439 million, $257 million worse than its year-ago loss.

The biggest issue in Europe right now is the sharp decline in new-vehicle sales in Russia, where Ford has made significant investments. For Europe as a whole, wholesale volume and revenue were actually up, 6% and 7%, respectively. But costs related to Russia -- and to a long-standing deal to sell components to Tata Motors' Jaguar and Land Rover, Shanks said -- weighed on Ford Europe's bottom line.

Ford reiterated the guidance it gave last month: It expects to lose about $1.2 billion in Europe for the full year. That's more than we'd hoped, but it's still a significant improvement over 2013's result. But next quarter's result could be ugly, to the tune of nearly $600 million; Ford lost $619 million in Europe through the first three quarters of 2014.

Middle East and Africa Ford's newest regional business unit was created in anticipation of long-term growth in a region with bright prospects over the next decade. Right now, though, results are modest: The unit lost $15 million in the third quarter, a $10 million improvement from a year ago. Wholesale volume and revenue were up 9% and 5%, respectively.

Ford expects the unit to break even for the full year. It's a work in progress.

Asia-Pacific Ford's Asia-Pacific region includes its massive and rapidly growing presence in China, now the world's largest auto market. Ford is aggressively investing in new factories and facilities in China and other key Asian markets; those investments have kept total profits from the region fairly modest, despite rapid sales growth.

For the third quarter, Ford Asia-Pacific reported a profit of $44 million, down $72 million from a year ago. Wholesale volume was up 5% from a year ago, and revenue up 3% -- but the Asia-Pacific revenue number excludes much of Ford's income from China, which is reported separately as equity income from joint ventures with local Chinese automakers.

The year-over-year decline has a lot to do with the costs of Ford's expansion effort. Shanks noted that Ford has five new factories under construction in the region, all of which are expected to open in the next nine months -- but nearly all of the workers for those factories have already been hired and are in training (and thus on payroll) right now.

Ford is also launching the Lincoln luxury brand in China, a huge and significant undertaking. Shanks said Ford sold its very first Lincoln in China earlier on Friday, but he also noted that the company spent quite a bit of money laying the groundwork for Lincoln's launch in the third quarter.

Ford reiterated its full-year guidance for Asia-Pacific: It expects to make about $700 million in the region this year. Through the first three quarters, the unit has posted $494 million in profit.

Ford Credit Ford's in-house financing arm is a conservatively managed operation that gives the Blue Oval a steady flow of profits from quarter to quarter. Ford Credit made $498 million in the third quarter, up $71 million from the year-ago period. A small year-over-year increase in credit losses was more than offset by higher loan volumes and improvements to Ford Credit's financing margin.

For the full year, Ford expects its financing unit to post about $1.8 billion in pre-tax profit. Through the first three quarters, Ford Credit has earned $1.39 billion.

Cash, special items, and other issuesFord's operating-related cash flow was negative by about $700 million during the quarter. That is largely explained by the combination of Ford's reduced profits and its high capital spending related to its ongoing new-product launch efforts, CEO Mark Fields said during Friday's quarterly conference call.

That spending also hit Ford's cash reserve: Gross cash on hand at the end of the quarter was $22.8 billion. That's still an ample reserve, but it's down about $3 billion from the end of the second quarter. Ford's debt stands at $14.9 billion, down by about $900 million from a year ago.

As noted above, Ford took special item charges of $160 million during the third quarter. That was mostly due to costs related to its European turnaround plan, including severance payments to workers laid off from a Belgian factory that is set to close at the end of the year.

The upshot: No surprises in Ford's guidance Ford warned last month that the third and fourth quarters would be tighter than the company had previously expected, as tough conditions in places including Russia and Brazil would combine with the high ongoing costs of new product launches to leave the company's bottom line well below year-ago levels. The company continues to expect its full-year pre-tax profit to come in at about $6 billion, significantly lower than its results in 2012 and 2013.

But the outlook for 2015 still looks pretty good, as that's when all of Ford's expensive investments should begin to pay off. It expects full-year 2015 pre-tax profit to be a lot higher -- in the $8.5 billion to $9.5 billion range -- with all of its regional units improving on 2014 results.